What is home bias?

It’s natural to want to back your home team, but this home bias also exists in investing choices.

Supporting without question who or what you know, trust and are loyal to can have costly consequences.

Home bias on the field
Many sports fans turn up at matches decked out in team colours and supporters kit, a visible reflection of their pride and enthusiasm. If they are putting this pride – or laying some money – on the line, people tend to back their own team, even if the odds are stacked against them.

Evidence gathered by German academics from online betting on European football, for example, finds many gamblers either put too much money on their own national team, or are reluctant to bet against it – even when that is probably the smartest bet.

In Soccernomics co-author Simon Kuper’s 2012 article for eZonomics on home bias, Kuper writes how British economists David Forrest and Robert Simmons showed that Spanish gamblers too often put money on clubs with the highest attendances – in short, on the most popular teams.

“In gambling, these kinds of irrational bets are known as ‘loyal money’,” Kuper wrote. The Spanish are far from the only nationality to display this tendency.

Home bias in investing locally
Where home bias might get even more serious if investors exhibit it as well. This can have negative implications for diversification and minimising financial risk.

One way of demonstrating this “home equity bias” is having a disproportionately large part of a shares portfolio invested in companies based at home. There can be a tendency to over-invest – and be overexposed – in your home market.

One aspect of diversification, in theory, is geographic, as developed markets (such as Europe and the United States) might offer slower growth but more stability, while emerging markets (such as India, China, Brazil and Russia) may offer the potential for more growth but also more risk. Putting a large share of your portfolio into household names and other companies in your country will not seem such a well thought out plan if the economy stumbles.

Home bias in industry
“Home” refers not only to the country we live in but other aspects of life that are familiar as well. The home bias in investing is also said to exist in the tendency to buy shares in firms in industries that investors themselves work in. Norwegian research finds people tend to hold more shares in firms and industries they work in.

Perhaps it is an employee share offer or the feeling that they know the market very well. Yet that study from Norway suggests these investments typically underperform the market.